5 Steps to Financing a Business Purchase

Business financing options are important whether you’re ready to buy a business you’ve been part of for years or want to acquire a competitor to expand your market share. Buying an existing company is often a smart move. You’re able to build on the branding, products, and customer base that the company has established, while improving operations through your own ideas and efforts. Financing the purchase of an existing business may be more complex than starting a new company, but a number of options are available to you. Here are five steps to help you navigate the world of business financing options.

Work with a business broker

Start your process by establishing a relationship with a business broker. According to Inc. Magazine, the best brokers will be members of the International Business Brokers Association and hold the Certified Business Intermediary (CBI) designation, or be members of the M&A Source with the M&AMI designation. Experienced brokers can help you manage the buying process from identifying the right business to securing funding. Brokers have wide networks within the financial world, and the experience to help you find the option that’s right for you. If the broker you’re working with represents the business seller, it’s important to consider that and make sure you have adequate representation.

Know your valuation and do your due diligence

Your broker will help you manage the valuation process. Plan to get second opinions from your attorney and CPA. Ensure that you understand how the business is being valued. For example, the Cash Flow Method looks at future cash flow to see what kind of loan the business can support. The Tangible Assets Method values a business based on its assets on the balance sheet. Different methods are acceptable and appropriate for diverse business models, but should be supported by your own due diligence. Most businesses are valued as a multiple of earnings (earnings before interest, taxes, depreciation and amortization, or EBITDA). Review at least three years of financial records, tax returns, contracts and leases, customer data, marketing materials, HR information, and any other facts you can gather.

Consider owner-financed purchases

According to the International Business Brokers Association, seller financing is becoming more common than other methods. Seller financing is an alternative to commercial bank or small business loans. Typically, the seller holds a note on the sale of a business for a period of up to ten years. Smaller monthly payments are generally arranged and one or more balloon payments pay off the majority of the debt. Seller financing demonstrates that a seller is invested in helping the new owner succeed. This can be very persuasive to banks when a buyer needs multiple funding sources to complete a deal. A business broker can help negotiate and structure an owner financed deal.

Regular bank loans may not be available to finance a small business purchase. Instead, buyers work with an SBA lender using an SBA 7(a) business acquisition loan. The SBA works with approved lenders (such as qualified banks) to offer SBA loans. The government backs these loans, lowering the risk for participating banks. Programs under this umbrella range from microloan initiatives offering under $50,000 to the Certified Development Company 504 Loan Program which helps businesses buy land and buildings.

Connect with angel investors and other high net worth people

Depending on the type of business you’re purchasing and its financial potential, an angel investor or venture capital firm might be the option to consider. Angel investors are high net worth individuals that offer money in exchange for equity in the company. High net worth people (and some private equity groups) sometimes offer private, unsecured loans called mezzanine financing. These loans often have higher interest rates. For individuals with a leaner credit history that don’t qualify for other options, angel investors are worth exploring. Business brokers often have a network of individuals in the market for specific deals; if your history and company meet their requirements, they can facilitate an introduction and structure a transaction.